Buy-Write Definition, Strategy, How It Works, Examples

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What is Buy-Write?

Are you interested in investing in the stock market? If so, you may have heard of a strategy called buy-write. But what exactly is buy-write and how does it work? In this article, we will explore the definition of buy-write, the strategy behind it, how it works, and provide some examples to help you better understand this investment strategy.

Definition

Buy-write, also known as a covered call, is an investment strategy where an investor buys a stock and simultaneously sells a call option on that stock. In simple terms, it involves buying a stock and writing (selling) a call option against it. The term “buy-write” is derived from the action of buying the stock and writing the call option.

In a buy-write strategy, the investor owns the underlying stock and sells call options with a strike price that is higher than the stock’s current market price. By selling a call option, the investor agrees to sell their shares at the strike price if the stock reaches that price before the call option expires.

How It Works

So, how does the buy-write strategy work? Let’s break it down into steps:

1. An investor buys a stock or already owns the stock.
2. The investor simultaneously sells a call option on that stock.
3. The call option has a strike price, which is the price at which the investor agrees to sell the stock if the stock reaches that price before the option expires.
4. The call option also has an expiration date, which is the date at which the option expires and becomes worthless if the stock price does not reach the strike price.
5. If the stock price reaches the strike price before the option expires, the investor sells their shares at the strike price.
6. If the stock price does not reach the strike price before the option expires, the investor keeps the premium received from selling the call option and still owns the stock.

The goal of the buy-write strategy is to generate income from the premiums received from selling call options, while potentially benefiting from potential share price appreciation. By selling call options, investors can earn income on their stock holdings, which can help offset any potential downside risk.

Examples

Let’s look at a couple of examples to better understand how the buy-write strategy works:

Example 1:

Suppose an investor owns 100 shares of XYZ Company, which is currently trading at $50 per share. The investor decides to sell a call option with a strike price of $55 and an expiration date of 30 days. The call option premium received is $2 per share.

Scenario 1: If the stock price stays below $55, the option expires worthless, and the investor keeps the $2 premium per share. The investor still owns the stock and can continue generating income by selling more call options.

Scenario 2: If the stock price increases to $60 before the option expires, the investor is obligated to sell their shares at the strike price of $55. The investor earns a profit of $5 per share from the stock price appreciation, in addition to the $2 premium received from selling the call option.

Example 2:

Suppose an investor buys 100 shares of ABC Company at $25 per share. The investor sells a call option with a strike price of $30 and an expiration date of 60 days. The call option premium received is $1 per share.

Scenario 1: If the stock price stays below $30, the option expires worthless, and the investor keeps the $1 premium per share. The investor still owns the stock and can continue generating income by selling more call options.

Scenario 2: If the stock price increases to $35 before the option expires, the investor is obligated to sell their shares at the strike price of $30. The investor earns a profit of $5 per share from the stock price appreciation, in addition to the $1 premium received from selling the call option.

These examples illustrate how the buy-write strategy can be used to generate income from selling call options while potentially benefiting from stock price appreciation.

Conclusion

Buy-write, or covered call, is an investment strategy that involves buying a stock and simultaneously selling a call option on that stock. This strategy allows investors to generate income from the premiums received from selling call options, while also potentially benefiting from potential share price appreciation. By utilizing the buy-write strategy, investors can enhance their investment returns and manage risk. However, like any investment strategy, it carries risks and should be carefully considered.